Using Domestic Asset Protection Trusts to Avoid Bankruptcy

Introduction

On March 2, 2005, the New York Times published an article contending that domestic asset protection trusts (DAPT), available in Alaska, Delaware, Nevada, Rhode Island and Utah, can be used to exempt assets from bankruptcy. Under these DAPT statutes, property held in these trusts do not belong to the individual, and state law governs whether an asset belongs to an individual and is therefore under the jurisdiction of the bankruptcy court.

Spendthrift Trusts

Bankruptcy law acknowleges that "spendthrift trusts" (a trust formed to protect the beneficaries from creditor claims) are not subject to the claims of creditors in bankruptcy. Generally, if a spendthrift trust is set up for education or retirement planning, it is exempted from the estate of a bankrupt individual. However, a debtor in bankruptcy cannot create a spendthrift trust to protect himself from creditors -- a so-called "self-settled spendthrift trust."

Domestic Asset Protection Trusts

In contrast, DAPTs allow for self-settled spendthrift trusts, thus, a wealthy person can transfer property to an asset protection trust and usually 2-4 years later (depending on state law)he can file for bankruptcy without subjecting the trust's assets to creditor's claims.

Note: Each state has provisions allowing creditors a time period to claim against the DAPT and requiring that the individual remain personally solvent after the transfer.

DAPTs are used to defeat potential creditors and are favored by those in high-risk professions, such as doctors, dentists, corporate executives, owners of companies and those dealing with federal and state security regulations that expose them to personal liability.

Note: DAPT statutes are relatively new and have not been exposed to rigorous court challenges. For instance, whether a California court will rule that a Nevada Spendthrift Trust shields assets from creditors of a California resident, a result that contradicts California's prohibition against self-settled spendthrift trusts, remains an open question.

Conclusion

Unless Congress amends the pending bankruptcy legislation, DAPTs will provide individuals with substantial assets with a way to shield those assets from creditors, even when the individual files for bankruptcy.